Uncertainty in the Oil Market

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Simplified overview of the market mechanism:

Understanding the nuances of the oil market can come off as very complicated at times, for what is perhaps the biggest resource of Natural gas. The availability of crude oil is not centralized, thus, different countries have different suppliers and the pricing of petroleum related products largely depends on the demand and supply of crude oil. In a simple flowchart, the entire procedure can be summed up into three parts, first where an entity explores, extracts and transports the crude oil to refineries, second where the crude oil is then converted into consumables such as diesel fuel and the third step is the distribution of such consumable substances. As stated before, being a decentralized market it has many stakeholders due to which the pricing may vary from producers, refiners, marketers, brokers, tradersand the consumers buying the final product. The volatility of the oil-based products is usually reduced by the insurance against business risks, the price regulation is majorly influenced by Organization of Petroleum Exporting Countries which account for producing more than 30% of the consumable products all over the world.

The Role of the OPEC:

Often characterized as a price determining cartel, the OPEC has downplayed many a times the possibility of vulnerable oil market spikes. The OPEC  was formed to counterbalance the exploitative rates of oil set by the seven private entities, including Mobil, Exxon, Gulf among others.  Initially, the OPEC members themselves had a very loose bound partnership yet conveniently decreased the market competition. By 1980, 200 years after its formation, even when selling as much oil as it did in 1973, the revenue doubled 5 times. The OPEC overreached itself in groping for higher prices in the late 1970’s: it lost control of its market and its revenue collapsed. The cause of its undoing was the 1979-80 price doubling to compensate for the loss due to issues with Iran[1]. Since then OPEC largely lost its monopoly over the market revenue as well as production yet remains as one the single most powerful price determining clubs in the sector, even more so when protected under the Doctrine of State immunity under International Law. When developing countries get into a collective initiative to control and regulate oil market prices, their individual motive to maximize their own revenue hinders in forming an amicable consensus. Critical to OPEC’s present and future performance is the action of non-OPEC producers. Since OPEC is the residual supplier to the world market, its market share depends not only on how fast the world market grows, but also on how fast the non- OPEC output grows.

Furthermore, the OPEC is not entirely united and free from outside influence. The political uncertainty concerning the major oil exporters from the Persian Gulf, it is only natural for governments of oil importing countries to attempt to secure future deliveries through long-term agreements with suppliers considered to be politically more stable, or to diversify their suppliers. The Saudi and Kuwait need military assistance from the United States and in return the US has its own cut from such aid.

Russia-Saudi Price War:

Saudi Arabia had very strong reaction to Russia’s unrelenting take on excessive oil production march of 2020. This occurred when the potential of COVID-19 had not been realized, the two countries produced more oil than what was there quota and thereby, violated the terms of OPEC+, a group having OPEC members and other major nation states having a major stake in oil production and refinery. Saudi Arabia is a major factor to reduce volatility in the oil market[2] although when it came to Russia’s excessive production, instead of keeping a check on it Saudi deliberately amplified the same.The Saudis have previously initiated such price wars to strengthen their position as the most prominent oil supplier, most recently in 2014, when OPEC members refused to cut production amid declining prices and rising US shale output.

As a result of this war, the prices touched a very significant low, considering the affect of COVID-19 with it. The price war led to severe uncalled repercussions such as an exacerbation in stock market[3] and the need for the world’s producers to slash spending, halt drilling, and shed workers.

Pandemic’s hit:

Most of the final products from oil are used in the transport industry and when a severely movement restricting Pandemic, the industry which relies on transportation is ought to be affected the worst.Loss of jobs and income reduction of those involved in the oil sector is very much likely and the extra oil launched into the market by Russia and Saudi Arabia has already lowered the cost. The International Energy Agency(IEA), in a report pointed out that the decrease in the demand could be cut by 4,25,000 barrels a day as the biggest consumers of the market such as China and the United States have had a partial or complete quarantine in place almost throughout the country and from daily public consumption to aircraft.

The Future of Oil Market:

It remains a largely speculative constraint of when masses would resume to their daily routine, without the fear of being infected with the virus considering the possibility of permanent takeaways from the lockdown causing less commuting or when would the stigma of flying overseas die out post-lockdown, oil demands are still likely to recover.According to the IEA, in what was the biggest barrels per day decline in a single year, a year and a half is what is predicted as the time for oil market to potentially recover. In the same report, IEA made it clear that major uncertainties lay on the market’s road to recovery, uncertainties which the IEA believes should not be underestimated and the recession is set to reduce the activities in the industry. 

Oil has been a strong determinant in matters of wealth, power and economy ever since industrialization. With its dynamic in the global sphere currently not holding the same post it did before in addition to tentative markets and the economic recession in this post pandemic world, one thing remains certain, this sector of oil might run as smoothly as before.

– Osho Dubey, 

Writer, Bharat Bhagya Vidhata

[1]Gately, Dermot. “Strategies for OPEC’s Pricing and Output Decisions.” The Energy Journal, vol. 16, no. 3, 1995, pp. 1–38. 

[2]Axel Pierru, James L. Smith, and TamimZamrik, “OPEC’s Impact on Oil Price Volatility: The Role of Spare Capacity,” The Energy Journal 39, no. 2 (2018).

[3] “Dow futures fall maximum amount allowed, poised to plunge 1,300 points at the open as oil prices deliver a punishing blow to Wall Street”. MarketWatch.

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